What It Really Costs To Mine Gold: The First Quarter Eldorado Gold Edition

| About: Eldorado Gold (EGO)


In an earlier article, we discussed one of the most important metrics to analyze the gold industry, the actual cost of mining an ounce of gold, which can help an investor figure out whether it is time to buy GLD and/or the gold miners. In that analysis, we used the FY2012 financials to calculate the combined results of publicly traded gold companies and come up with a true all-in industry average cost of production to mine each ounce of gold.

In this analysis, we will calculate the true costs of production of Eldorado Gold (NYSE:EGO), a gold producer that owns operating mines in China, Turkey and Greece. In addition, EGO owns two base metal mines located in Brazil (an iron-ore mine) and Greece (a base metal mine). EGO also owns a few development projects located in China, Greece, Turkey and Romania.

One thing that investors should note is that EGO owns development properties (and one operating mine) in Greece - which is a country with significant political risk. Investors in EGO should follow developments in Greece closely.

Calculating the True Mining Cost of Gold - Our Methodology

In the previously mentioned article, we gave a thorough overview of the current way mining companies report their costs of production and why it is inaccurate and significantly underestimates total costs. Then we presented a more accurate methodology for investors to use to calculate the true costs of mining gold or silver. Please refer to that article for the details explaining this methodology, which is an important concept for all precious metals investors to understand.

Explanation of Our Metrics

Cost Per Gold-Equivalent Ounce - is the costs incurred for every payable gold-equivalent ounce. It is Revenues minus Net Income, which will give an investor total costs. We use payable gold and not produced gold, because payable gold is the gold that the miner actually keeps and is more reflective of their production. Miners also use payable gold and not produced gold when calculating their cash costs, so this is pretty standard.

We then add Derivative Gains (or minus Derivative Losses) which will give investors total costs without the effects of derivatives. Finally, we add Foreign Exchange Gains (or minus Foreign Exchange Losses) to remove the effects of foreign exchange on the company's costs.

Cost Per Gold-Equivalent Ounce Excluding Write-downs - is the above-mentioned "cost per gold-equivalent ounce" minus Property/Investment Write-downs and Asset Sales. This provides investors with a metric that removes exceptional gains or losses due to write-downs and asset sales.

Cost Per Gold-Equivalent Ounce Excluding Write-Downs and Adding Smelting and Refining Costs - is the above-mentioned "cost per gold-equivalent ounce excluding write-downs" adding in smelting, refining and all other necessary pre-revenue costs. This is a new metric that we are now introducing to our true all-in cost series because it will more accurately measure all-in costs and allow comparisons between miners.

Most investors are unaware that many miners will remove smelting, refining and other costs before reporting their total revenues figures and these pre-revenue costs are not reported in the income statement. The result of this is that it skews all-in costs higher for miners that refine themselves or include the costs in their income statement while inaccurately showing lower costs for miners that remove it before reporting revenues.

A simple test can be done on any miner to see if there are any pre-revenue costs that are not reported in the income statement. Simply take payable production and multiply it by average realized sales price and this should come relatively close to the total revenues figure. If it gives you a number much higher than reported revenues then there are pre-revenue costs that are not being reported.

This line should alleviate these issues and allow comparisons on a fair basis.

Real Costs of Production for EGO - 1Q13 and FY2012

Let us use this methodology to take a look at EGO's results and come up with the true cost figures for each ounce of EGO's production. When applying our methodology, we standardized the equivalent ounce conversion to use the average LBMA price for Q4FY12. This results in an iron-to-gold ratio of 14.35:1 - iron tonnes to ounces of gold.

Additionally, EGO mines a concentrate mix of lead and zinc at its Stratoni mine in Greece and we converted this mix to gold at a 1.9:1 ratio of tonnes of concentrate to ounces of gold, which was based on the average yearly price for each sold tonne of concentrate. We like to be precise, but minor changes in these ratios have little impact on the total average price - investors can use whatever ratios they feel most appropriately represent the by-product conversion.

Observations for EGO Investors

True Cost Figures - EGO's true all-in costs for Q1FY13 were $1,403 per gold ounce, which was higher on a year-over-year basis ($1,101 for Q1FY12) and a sequential basis ($1094 Q4FY12). Additionally, compared to FY2012 this quarter was much higher than their average $1,119 true all-in cost.

The biggest reason why EGO's earnings did not reflect these higher true all-in costs is because they sold about 25,000 ounces of gold more than they produced. At $1,622 per ounce, that boosted revenues by around $40 million, which significantly benefited bottom-line earnings.

Compared to competitors, EGO's first quarter was a bit higher and compares to competitors such as Yamana Gold (NYSE:AUY) (costs just over $1,300), Gold Fields (NYSE:GFI) (costs over $1,500), Randgold (NASDAQ:GOLD) (costs just under $1,200), Allied Nevada Gold (NYSEMKT:ANV) (costs just under $1,000), IAMGOLD (NYSE:IAG) (costs around $1,400), Goldcorp (NYSE:GG) (costs just under $1,200), SilverCrest Mines (NYSEMKT:SVLC) (costs below $1,100), Kinross Gold (NYSE:KGC) (costs just under $1,400), Alamos Gold (NYSE:AGI) (costs under $1,100), Newmont Gold (NYSE:NEM) (costs around $1,300), Agnico-Eagle (NYSE:AEM) (costs around $1,400), and Barrick Gold (NYSE:ABX) (costs around $,1200).

We want to stress that EGO is starting up its Greek Olympias mine (commercial production expected to commence in Q2FY13), so true all-in costs will be a bit higher without the associated increase in production until Olympias is fully operational. Additionally, one quarter high costs is not necessarily a cause for alarm in investors, but costs were significantly higher than previous quarters

Corporate Liquidity - Liquidity is very important for investors to monitor in this current low-price gold environment, especially for producers that have true all-in costs above the current spot gold price. EGO had $669 million in cash and deposits and another $159 million in term deposits. Even with the $583 million in debt, EGO remains very liquid and has sufficient liquidity for the future, assuming no significant costs associated with Olympias development or cash held in Greece or foreign countries.

Production Numbers - Gold production increased on a quarter-over-quarter basis from 155,535 ounces to 163,768 gold ounces, which is about a 5% increase. But production did drop sequentially from Q4FY12 from 190,530 gold ounces to 163,768 ounces, which is a significant 15% drop in gold production. EGO may have a tough time of matching 2012 gold production of 656,000 ounces unless Olympias production significantly increases total gold production. Again, we would not make too much of one quarter's drop in production though investors should monitor this situation closely.


On a true all-in costs basis, EGO's Q1FY13 production costs left a lot to desire for investors and came to $1403 per gold-equivalent ounce - though we would stress that it is developing the Olympias mine so this would contribute to a higher than normal true all-in cost. This was coupled with a drop in sequential gold production, which investors should not overreact to but should also make sure they monitor this development in future quarters.

For investors interested in gold as a commodity (GLD and PHYS investors take note), EGO's report is another example of the increasing costs of production that we are seeing in the gold mining industry. This is coupled with a declining amount of gold produced even as gold prices averaged $1,622 (for EGO) in the first quarter, which is significantly higher than current gold prices.

This is very bullish for physical gold and gold ETF investors because we believe that this will lead to significant drops in gold production. Since gold production is actually very important to gold supply, drops in gold production will decrease the gold supply picture and provide support for the gold price. Gold investors should take the initiative and increase their positions accordingly because the negative sentiment in gold may not last long as physical demand starts taking control of the gold price.

Disclosure: I am long SGOL, EGO, GG, AGI, SVLC, SIVR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.